by Paula Schaap ,Senior Reporter , February 10, 2010
AUA Goes Over $2.2T in Q4 2009
What a difference six months makes.
In March 2009, the Dow Jones Industrial Average had slid to 6,547, the lowest the index had been since the late 1990s. Doom-sayers were saying that it would sink far lower, with 5,000 and even 4,000 predicted as just around the corner.
Then, a funny thing happened on the way to the bottom. Turned out, that was the bottom.
Hedge fund firms, which, by and large, had an awful 2008, experienced a renaissance in 2009. The HFN Hedge Fund Aggregate Index was up 19.44% in 2009 as compared to 2008’s -15.74%.
Of course, one of the reasons the bottom wasn’t farther down was because the federal government poured money into Wall Street and other areas of the economy, most notably and controversially, the Treasury Department’s $700 billion Troubled Asset Relief Program.
However that may be, the turnaround has done good things for the hedge fund industry, and along with it, the firms that provide its critical support systems: administrators. Now, more than ever, third-party administration firms are the keystone to the health and welfare of the asset class.
The 2009 Q4 HFN Hedge Fund Administrator Survey, reported hedge fund assets under administration as over $2 trillion. The survey had 55 administrators reporting.
The median growth rate in the second half of 2009 was +12.02%. The 10 largest administration firms reported average growth of +11.22% in the second half of the year.
The vast majority of administrators reported a rise in AUA in the second half of last year, about 83%.
Mike Sleightholme, Citi’s Head of Hedge Fund Services, North America, says his business has seen a significant shift in terms of the kinds of firms they are talking to.
“We’re now talking to larger, established firms that are seeking to outsource functions instead of doing it in-house,” Sleightholme says.
Investors and Managers Demand More
That shift has come mostly because investor demands, Sleightholme feels.
“Number one is investor pressure to establish independent service provider relationships for administration and custody. Clearly, they are saying they want a third party involved,” he says.
Robin Bedford, the chief executive officer of Opus Fund Services, says, “It didn’t happen on day one that all managers who were self-administering suddenly picked up the phone and said, ‘Can we outsource our work to you.’ We’ve seen a more gradual move in that direction with investor-driven requests for fund managers to consider independent fund administration.”
The turnaround in the hedge fund industry coupled with demands by investors and managers alike for a more thoroughgoing due diligence process has upped demands for exactly the kinds of services administrators are positioned to provide.
“What we’ve seen is that the due diligence process by institutional investors is much more robust,” says Joe Holman, founder and managing partner of Columbus Avenue Consulting. “Before people were happy to see an administrator, but now they want one that does the work in a ‘best practice’ method.
“NAV-lite is no longer acceptable,” Holman says.
Omnium’s president John Buckley — Omnium is the rebrand of hedge fund firm Citadel Group’s administration services division — says his firm is responding to the needs of both managers and investors.
“A CFO or operations manager needs access to information; a portfolio manager needs access to positions and risk parameters to trade the portfolio; and an investor may need access to understand the investment,” Buckley says. “All three of those roles call for an ability to deliver data across multiple constituents seamlessly.”
In a post-Bernard Madoff world, there is often a desire for a “second set of eyes” on the administration process, according to Francis Rainsford, executive vice president of Viteos Fund Services. Viteos CEO Shankar Iyer says that shadow accounting and middle office outsourcing accounts for 50% of the firm’s business with direct fund administration filling in the other half.
“The need for it is coming from heightened due diligence out of concerns about fraud and other problems,” Iyer says.
“It also happens when you want to launch a new fund in an asset class that you haven’t previously invested in and you don’t have the technology internally to support such assets,” he adds.
It’s About the Technology
Technology, technology, technology, was the refrain hammered home by every administration executive. As in, what do clients really want?
For example, Buckley says, Omnium was able to build its administrative services based on Citadel’s own technology.
“Clients want online, live information to manage both complex and simple strategies, and we provide this in a web-delivered platform powered by leading edge technology,” Buckley says.
One of the areas Omnium is seeing more demand is from institutions that are in the process of building their own in-house alternative investment divisions, Buckley says.
“These clients can license Citadel Technology and Omnium services so that they can build an effective alpha platform,” he says.
Over on the funds-of-funds side, Sleightholme says the call is for greater liquidity reporting.
“We are developing enhanced liquidity reporting to be able to match investor liquidity with investment liquidity,” he says. “This is so that funds can see ‘what’s my redemption exposure over a given period as opposed to the underlying funds we’re invested in;’ so they can see how much they need to meet possible redemption requests.”
Holman says he sees hedge funds looking for more help on the accounting side.
“They’re looking for the fund administrator to be able to apply detailed exposure and attribution reporting and they want it provided in some sort of electronic fashion.”
Pricing Linked to Services is Key
Although funds are coming back, many of the administrator executives interviewed for this article said they are seeing changes in fund size.
Sleightholme, however, notes that whatever the package of fund services, customer service is still crucial.
“The more significant trend is that clients are asking us to do more, rather than paying less to do the same. But the most important thing [for the firms] is client services so there is a premium placed on top service,” he says.
“In prior years, you’d get $10 million from an institution, today you might get $5 million,” Holman says. “It seems like you have a lot of people contributing money, but they’re all contributing smaller sums of money.”
That has led to some creative service and pricing offerings on administrators’ part.
Bedford says Opus’ technology has the advantage of appealing to clients of all sizes because the firm employs fixed-fee pricing.
“[That] means that our fees reflect the work that we are required to perform, not the size of our clients’ assets under management,” Bedford says.
Holman says Columbus Avenue has come up with a way to deliver a basic administration service for the newer fund launches that tend to be smaller than in prior years.
“We can offer the basic service of creating books and records to support year-end audit and reports to investors,” he says. “By doing that, we can reduce our fee to allow managers with $10 million to afford a top-level administrator.”
Looking Forward into 2010
Looking forward, Iyer says, he expects the upswing in the hedge fund industry to continue.
“If the Volcker rule [limiting proprietary trading at banks], goes into effect, you will have so many proprietary desk traders coming into the business,” he says. “We’re not up to the 2003 to 2006 growth of hedge funds; I’m not even saying we can see it in the pipeline yet. But definitely the activity levels are far, far more than last year.
Another likely impetus for hedge fund firms to turn to third-party administrators, as well as demand more from their current administrators is the push by legislators, for greater regulation of the asset class.
“We also believe the level of information and disclosure on the back of likely regulation will increase a client’s need and ability to access information to respond to investors, regulators and auditors,” Buckley says.
Holman says his firm is expecting to grow and plans to hire.
“We’re certainly not at capacity,” he says, but then adds, laughing, “Me personally, I’m at capacity.”